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UNITED STATES

FORM 10-Q

OR

Commission File No. 001-31353

EMULEX CORPORATION

(714) 662-5600
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  [X] No [  ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes  [X] No [  ]

As of November 5, 2003, the registrant had 82,859,725 shares of common stock outstanding.

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EMULEX CORPORATION AND SUBSIDIARIES

INDEX

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

EMULEX CORPORATION AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(in thousands, except share data)
(unaudited)

See accompanying notes to condensed consolidated financial statements.

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EMULEX CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Income
(in thousands, except per share data)
(unaudited)

See accompanying notes to condensed consolidated financial statements.

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EMULEX CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)

See accompanying notes to condensed consolidated financial statements.

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EMULEX CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements

1.		Summary of Significant Accounting Policies and Basis of Presentation
		In the opinion of the Company, the accompanying unaudited condensed consolidated financial statements contain all adjustments (which are normal recurring accruals) necessary to present fairly its financial position as of September 28, 2003, and June 29, 2003, and its condensed consolidated statements of income for the three months ended September 28, 2003, and September 29, 2002, and its condensed consolidated statements of cash flows for the three month periods then ended. Interim results for the three months ended September 28, 2003, are not necessarily indicative of the results that may be expected for the year ending June 27, 2004. The interim financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the fiscal year ended June 29, 2003.
		Recently Adopted Accounting Standards
		The Emerging Issues Task Force (“EITF”) recently reached a consensus on its tentative conclusions for EITF 00-21, “Revenue Arrangements with Multiple Deliverables.” EITF 00-21 provides accounting guidance for customer solutions where delivery or performance of products, services and/or performance may occur at different points in time or over different periods of time. Companies are required to adopt this consensus for fiscal periods beginning after June 15, 2003. The adoption of EITF 00-21 did not have a material impact on the Company’s financial position, results of operations or liquidity.
		In April 2003, the Financial Accounting Standards Board, (“FASB”) issued Statement 149, an amendment of FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities,” which requires prospective application for contracts entered into or modified after June 30, 2003, except for contracts that exist in fiscal quarters that began prior to June 15, 2003, and for hedging relationships designated after June 30, 2003. For existing contracts in fiscal quarters that began prior to June 15, 2003, the provisions of this Statement that relate to Statement 133 implementation issues should continue to be applied in accordance with their respective effective dates. Statement 149 requires that contracts with comparable characteristics be accounted for similarly. The adoption of this pronouncement did not have a material impact on the Company’s financial position, results of operations or liquidity.
		In May 2003, the FASB issued Statement 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” Statement 150 establishes standards for classifying and measuring certain financial instruments with characteristics of both liabilities and equity. Statement 150 requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances) because that financial instrument embodies an obligation of the issuer. Statement 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective for public companies during the first interim period beginning after June 15, 2003. The adoption of this pronouncement did not have a material impact on the Company’s financial position, results of operations or liquidity.
		Stock-Based Compensation
		In December 2002, the FASB issued Statement 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.” Statement 148 amends the disclosure requirements in Statement 123, “Accounting for Stock-Based Compensation” for annual periods ending after December 15, 2002, and for interim periods beginning after December 15, 2002. The Company adopted the disclosure provisions of Statement 148 during the three months ended March 30, 2003. Effective for financial statements for fiscal years ending after December 15, 2002, Statement 148 also provides three alternative transition methods for companies that choose to adopt the fair value measurement provisions of Statement 123. Should the Company be required to adopt the fair value measurement provisions of Statement 123 and Statement 148, it would have a material non-cash impact on the Company’s results of operations. However, the Company has no plans to adopt the fair value measurement provisions of Statement 123 unless required to under new accounting standards and, as such, the adoption of Statement 148 did not have a material impact on the Company’s financial position, results of operations or liquidity.

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EMULEX CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements

The Company accounts for its stock-based awards to employees using the intrinsic value method under Accounting Principles Board (“APB”) Opinion No. 25 and related Interpretations. Stock-based awards to non-employees, if any, are recorded using the fair value method. Had the Company determined compensation cost based on the fair value at the grant date for all its stock options under Statement 123, the Company’s net income would have been the pro forma amounts indicated below:

The fair value of each option granted during the three months ended September 28, 2003, and September 29, 2002, was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions:

The Black-Scholes model, as well as other currently accepted option valuation models, was developed to estimate the fair value of freely-tradable, fully-transferable options without vesting restrictions, which significantly differ from the Company’s stock option plans. These models also require highly subjective assumptions, including future stock price volatility and expected time until exercise, which greatly affect the calculated fair value on the grant date.

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EMULEX CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements

2.		Inventories
		Inventories, net, are summarized as follows:

		Starting in late September 2001, some of the Company’s major customers made announcements that general economic conditions, exacerbated by the increase in economic uncertainty in the aftermath of the terrorist events of September 11, 2001, were having a negative impact on their financial results. The announcements made, and forecasts received, indicated deteriorating demand for the Company’s one gigabit per second (“Gbps”) products as these customers were expected to migrate to two Gbps products for future purchases. As a result, the Company recorded an excess and obsolete inventory charge totaling $13.6 million during the three months ended September 30, 2001. After initially recording its one Gbps reserve in September 2001, the Company has subsequently reduced this reserve by a total of $8.7 million through September 28, 2003, as previously-reserved inventory has been sold. Overall, the Company has been able to recover a significant portion of this reserved inventory that was not expected based on the Company’s forecasts and the forecasts received from its customers when this excess and obsolete inventory charge was recorded. In addition to the sale of some of this previously-reserved product, the Company has also scrapped $3.4 million of this reserved inventory and negotiated and paid cancellation charges of $0.2 million through September 28, 2003, related to this excess and obsolete inventory charge since it was initially recorded. As of September 28, 2003, the remaining reserve for one Gbps products was $1.3 million. However, as with all inventory, the Company regularly compares forecasted demand for its one Gbps products against inventory on hand and open purchase commitments and accordingly, the Company may have to record reductions to the carrying value of excess and obsolete inventory if forecasted demand decreases. As of September 28, 2003, the Company had unreserved one Gbps inventory on hand of approximately $0.9 million.
3.		Goodwill and Other Intangibles
		Goodwill and other intangibles, net, are as follows:

		Effective July 1, 2002, the Company adopted Statement 142, “Goodwill and Other Intangible Assets” and, as a result, the Company ceased amortizing goodwill of $397.3 million beginning July 1, 2002. Goodwill will be tested for impairment at least annually, but also on an interim basis if an event or circumstance indicates that it is more likely than not that an impairment loss has been incurred.
		The remaining intangible assets subject to amortization are being amortized on a straight-line basis over seven years. Aggregated amortization expense for these intangibles for the three months ended September 28, 2003, and September 29, 2002, was $1.5 million in each period and for the next five full fiscal years is expected to be (in thousands):

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EMULEX CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements

4.		Other Assets
		Components of other assets are as follows:

5.		Accrued Liabilities
		Components of accrued liabilities are as follows:

		Deferred revenue includes an accrual for estimated returns and allowances of $1.5 million and $1.9 million at September 28, 2003 and June 29, 2003, respectively. Deferred revenue also includes the revenue related to legacy cLAN products with unspecified upgrade rights of $0.1 and $0.2 million at September 28, 2003, and June 29, 2003, respectively.
		The Company provides a warranty of between one and three years on its Fibre Channel and Internet Protocol products and provides a warranty of between one and five years on its traditional networking products. The Company records a provision for estimated warranty related costs at the time of sale based on historical product returns and the Company’s expected future cost of fulfilling its warranty obligations.
		Changes to the warranty reserve for the three months ended September 28, 2003, and September 29, 2002, were:

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EMULEX CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements

6.		Convertible Subordinated Notes
		On January 29, 2002, the Company completed a $345.0 million private placement of 1.75 percent convertible subordinated notes due February 1, 2007. Interest is payable in cash on February 1 and August 1 of each year beginning August 1, 2002. These notes may be converted by the holder at any time into shares of the Company’s common stock at the conversion price of $53.84 per share, subject to the potential adjustments described in the terms of the notes issued. The Company may redeem the notes on or after February 5, 2005, in whole or in part. The Company incurred associated issuance costs of approximately $11.0 million (see note 4).
		During the three months ended September 29, 2002, the Company’s Board of Directors expanded the Company’s stock repurchase program to include repurchase of the Company’s convertible subordinated notes as well as shares of the Company’s common stock. In August 2002, the Company bought back at a discount to face value approximately $136.5 million in face value of its convertible subordinated notes for $104.2 million. The resulting net pre-tax gain of $28.7 million was recorded for the three months ended September 29, 2002. The repurchased notes were cancelled, leaving convertible subordinated notes outstanding with a face value of $208.5 million, which, if converted, would have resulted in the issuance of approximately 3.9 million shares.
		During the three months ended September 28, 2003, the Company’s Board of Directors expanded the Company’s stock repurchase program to include the repurchase of all of the Company’s convertible subordinated notes and extended the entire program to June 2005. The combined program authorizes the repurchase of up to 4.0 million shares of common stock and the repurchase of all of the remaining outstanding convertible subordinated notes. Also during the three months ended September 28, 2003, the Company bought back approximately $93.9 million in face value of its convertible subordinated notes at a discount to face value for approximately $87.3 million. The resulting net pre-tax gain of approximately $4.7 million was recorded in the three months ended September 28, 2003. The repurchased notes were cancelled, leaving convertible subordinated notes outstanding with a face value of approximately $114.6 million that, if converted, would result in the issuance of approximately 2.1 million shares. At September 28, 2003, 3.0 million shares of common stock and all of the $114.6 million face amount of the outstanding convertible subordinated notes remained authorized for repurchase.
7.		Commitments and Contingencies
		Litigation
		Beginning on or about February 20, 2001, the Company and certain of its officers and directors were named as defendants in a number of securities class action lawsuits filed in the United States District Court, Central District of California. The plaintiffs in the actions represent purchasers of the Company’s common stock during various periods ranging from January 18, 2001, through February 9, 2001. The complaints allege that the Company and certain of its officers and directors made misrepresentations and omissions in violation of sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended. The complaints generally seek compensatory damages, costs and attorney’s fees in an unspecified amount. Pursuant to a Stipulation and Court Order, the actions were consolidated. On August 24, 2001, an Amended and Consolidated Complaint was filed. Defendants’ motion to dismiss was denied by way of an order dated March 7, 2002. Defendants’ motion for reconsideration of that order was denied by an order dated May 3, 2002. Plaintiffs commenced discovery. The court certified the class action by an order dated September 30, 2002. Following these class action lawsuits, a number of derivative cases were filed in state courts in California and Delaware, and in federal court in California, alleging that certain officers and directors breached their fiduciary duties to the Company in connection with the events alleged in the class action lawsuits. The derivative cases filed in California state courts were consolidated in Orange County Superior Court and plaintiffs filed a consolidated and amended complaint on January 31, 2002. On May 10, 2002, the Orange County Superior Court ordered that the consolidated actions be stayed pending resolution of the federal class action described above. The derivative suit in Delaware was dismissed on August 28, 2001. On March 15, 2002, the United States District Court for the Central District of California ordered that the federal derivative action be stayed pending resolution of the class action lawsuit described above. The Company has received inquiries about events giving rise to the lawsuits from the Securities and Exchange Commission and the Nasdaq Stock Market. On

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EMULEX CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements

		April 22, 2003, the Company entered into two Memoranda of Understanding (“MOU’s”) agreeing to terms of settlement of both the class action and derivative litigation. The MOU’s call for settlement payments totaling $39.0 million, plus up to $0.5 million of the cost of providing notice to the class members. A Final Order and Judgment was approved by the court in the derivative cases on May 30, 2003, based on a Stipulation of Settlement of Derivative Claims dated as of May 13, 2003. An Order Preliminarily Approving Settlement and Providing for Notice was approved by the court in the federal class action on July 11, 2003, based on a Stipulation of Settlement dated as of July 3, 2003. A Settlement Hearing was held on October 15, 2003, in the federal class action, and the settlement was approved. As a result, the $39.5 million of restricted cash held in escrow was paid subsequent to September 28, 2003. Insurance proceeds are expected to reimburse the Company for a minimum of approximately $12.5 million of the settlement payments, in addition to $2.5 million for legal expenses, some of which has already been received by the Company. The probable net effect of the settlements to the Company, based on the Company’s current minimum estimate of reimbursement from the insurance carriers, is expected to be approximately $27.0 million, or $16.7 million after tax, recorded during 2003. The Company commenced an arbitration proceeding against three of its insurance carriers in June 2003 seeking reimbursement of $30.0 million for the defense and settlement costs.
		Additionally, the Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company’s consolidated financial position, results of operations or liquidity.
		Other Commitments and Contingencies
		The Company recorded an estimated excess and obsolete inventory charge of $13.6 million associated with older-generation one Gbps products during the three months ended September 30, 2001. After initially recording its one Gbps reserve in September 2001, the Company has subsequently reduced this reserve by a total of $8.7 million through September 28, 2003, as previously-reserved inventory has been sold. Overall, the Company has been able to recover a significant portion of this reserved inventory that was not expected based on the Company’s forecast and the forecasts received from its customers when this excess and obsolete inventory charge was recorded. In addition to the sale of some of this previously-reserved product, the Company has also scrapped $3.4 million of this reserved inventory and negotiated and paid cancellation charges of $0.2 million through September 28, 2003, related to this excess and obsolete inventory charge since it was initially recorded. As of September 28, 2003, the remaining reserve for one Gbps products was $1.3 million. However, as with all inventory, the Company regularly compares forecasted demand for its one Gbps products against inventory on hand and open purchase commitments and accordingly, the Company may have to record reductions to the carrying value of excess and obsolete inventory if forecasted demand decreases. As of September 28, 2003, the Company had unreserved one Gbps inventory on hand of approximately $0.9 million.
		The Company was previously required to enter into end-of-life purchase agreements for two key inventory components as the sole-source manufacturers of these components announced their discontinued manufacturing of the components. As of September 28, 2003, the Company’s remaining purchase obligation for the two components was $17.5 million.
		During the third quarter of fiscal 2002, the Company entered into an agreement to relocate its headquarters locally in Costa Mesa, California. The Company is financing the build-to-suit construction phase of the new facility with its own capital, before beginning a 10-year lease term with an option to buy the land and buildings during the first six months of the lease term. If the Company does not exercise its option to purchase the facility, the landlord will obtain permanent financing and reimburse the Company for the construction costs. Construction on the Company’s new corporate headquarters is progressing. If purchased, the Company believes the total cost, including the land, building and other related capital expenditures, would be approximately $47.0 million. The Company’s total gross undiscounted financial commitment for the 10-year lease term would be approximately $45.9 million. At September 28, 2003, the Company had restricted cash of $3.7 million held in escrow associated with the construction of the headquarters. In addition, the Company has a $1.0 million letter of credit in place in lieu of a rental deposit on one of its other facilities.

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EMULEX CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements

8.		Earnings per Share
		Basic net income per share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted net income per share is computed by dividing adjusted net income by the weighted average number of common shares outstanding during the period increased to include, if dilutive, the number of additional common shares that would be outstanding if the dilutive potential common shares from stock option plans and convertible subordinated notes had been issued. The dilutive effect of outstanding stock options is reflected in diluted net income per share by application of the treasury stock method. The following table sets forth the computation of basic and diluted net income per share:

		The antidilutive options were excluded from the computation of diluted net income per share because the options’ exercise price was greater than the average market price of the common shares during the three months ended September 28, 2003, and September 29, 2002.
9.		Subsequent Events
		On October 8, 2003, the Company and Vixel Corporation, a Delaware corporation (“Vixel”), announced that the two companies have signed a definitive agreement for the Company to acquire Vixel, a leading supplier of embedded switch ASICs and subsystems for the storage networking market. Under the terms of the agreement, the Company will acquire Vixel for $10 per share in cash, for an estimated transaction value of approximately $310.0 million. The acquisition is structured as a cash tender offer for all of the shares of Vixel. Any Vixel shares not acquired by Emulex in the tender offer will be acquired in a second step merger in which remaining Vixel shareholders will receive the same cash price per share as that paid in the tender offer. In addition, the Company will assume all existing vested and unvested Vixel stock options. The tender offer is expected to be completed in November 2003, subject to regulatory approvals and certain closing conditions, including the tender of a majority of shares of capital stock of Vixel on a fully-diluted basis.
		On October 17, 2003, the Company acquired the technology assets of Trebia Networks, Inc. and Trebia Networks Securities, Inc. The acquired technology includes multiprotocol storage networking processor

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EMULEX CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements

		architectures and high-performance offload engines. The purchase price was $2.0 million in cash, with $0.5 million of that amount placed in an escrow account for at least 90 days.
		The purchase price allocations have not been finalized for the pending Vixel acquisition and the completed Trebia technology asset acquisition. However, significant amounts may be allocated to in-process research and development (“IPR&D”) and to intangible assets, resulting in IPR&D expense and/or intangible asset amortization expense that would have a significant impact on the Company’s results of operations.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

Certain statements contained in this Form 10-Q may constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. We may also make forward-looking statements in other reports filed with the Securities and Exchange Commission, in materials delivered to stockholders and in press releases. In addition, our representatives may from time to time make oral forward-looking statements. Forward-looking statements provide current expectations of future events based on certain assumptions and include any statement that does not directly relate to any historical or current fact. Words such as “anticipates,” “in the opinion,” “believes,” “intends,” “expects,” “may,” “will,” “should,” “could,” “plans,” “forecasts,” “estimates,” “predicts,” “projects,” “potential,” “continue” and similar expressions may be intended to identify forward-looking statements.

Actual future results could differ materially from those described in the forward-looking statements as a result of a variety of factors, including those discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations set forth below, and, in particular, the subsection entitled “Risk Factors” set forth therein, and in our most recently filed Annual Report on Form 10-K. These factors include risks related to the proposed acquisition of Vixel and the fact that the economy generally, and the technology and storage segments specifically, have recently been in a state of uncertainty making it difficult to determine if past experience is a good guide to the future and making it impossible to determine if markets will grow or shrink in the short term. Recently, our results have been significantly impacted by a widespread slowdown in information technology investment that has also pressured the storage networking market that is the mainstay of our business. A continued downturn in information technology spending could adversely affect our revenues and results of operations. As a result of this uncertainty, we are unable to predict with any accuracy what future results might be. Other factors affecting these forward-looking statements include, but are not limited to, the following: slower than expected growth of the storage networking market or the failure of our Original Equipment Manufacturer, or OEM, customers to successfully incorporate our products into their systems; our dependence on a limited number of customers and the effects of the loss of, or decrease or delays in orders by, any such customers, or the failure of such customers to make payments; the emergence of new or stronger competitors as a result of consolidating movements in the market; the timing and market acceptance of our or our OEM customers’ new or enhanced products; the variability in the level of our backlog and the variable booking patterns of our customers; the effects of terrorist activities and resulting political or economic instability; the highly competitive nature of the markets for our products as well as pricing pressures that may result from such competitive conditions; our ability and the ability of our OEM customers to keep pace with the rapid technological changes in our industry and gain market acceptance for new products and technologies; the effect of rapid migration of customers towards newer product platforms; possible transitions from board level to application specific integrated circuit, or ASIC, solutions for selected applications; a shift in unit product mix from high-end to midrange products; a decrease in the average unit selling prices or an increase in the manufactured cost of our products; delays in product development; our reliance on third-party suppliers and subcontractors for components and assembly; any inadequacy of our intellectual property protection or the potential for third-party claims of infringement; our ability to attract and retain key technical personnel; our dependence on foreign sales; the effect of our stock price on stock compensation charges; the effect of acquisitions; changes in tax rates or changes in accounting standards.

Readers should carefully review these cautionary statements since they identify certain important factors that could cause actual results to differ materially from those in the forward-looking statements and from historical trends and are in addition to other factors discussed elsewhere in this Form 10-Q, in our filings with the Securities and Exchange Commission or in materials incorporated therein by reference. We caution the reader, however, that these lists of risk factors may not be exhaustive. We expressly disclaim any obligation or undertaking to release publicly any updates or changes to these forward-looking statements that may be made to reflect any future events or circumstances.

Company Overview

Emulex Corporation is a leading designer, developer and supplier of a broad line of storage networking host bus adapters, or HBAs, and ASICs that provide connectivity solutions for storage area networks, or SANs, network attached storage, or NAS, and redundant array of independent disks, or RAID, storage. HBAs are the data communication products that enable servers to connect to storage networks by offloading communication-processing tasks as information is delivered and sent to the network. Our products are based on internally developed ASIC and embedded firmware and software technology, and offer support for a wide variety of SAN protocols, configurations, system interfaces and operating systems. Emulex’s architecture offers customers a stable applications program

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interface, or API, that has been preserved across multiple generations of adapters and to which many of the world’s leading OEMs have customized software for mission-critical server and storage system applications.

Substantially all of our revenues during the first quarter of fiscal 2004 ended September 28, 2003, were comprised of products based on Fibre Channel technology. Our Fibre Channel development efforts began in 1992, and we shipped our first Fibre Channel product in volume in 1996. According to IDC and Gartner Dataquest, in calendar 2002 we were the world’s largest provider of Fibre Channel host bus adapters, in terms of revenue, ports and units shipped. Emulex has secured significant customer relationships with the world’s leading storage and server suppliers, including Dell, EMC, Fujitsu-Siemens, Groupe Bull, Hewlett-Packard, Hitachi Data Systems, IBM, NEC, Network Appliance and Unisys. In addition, we include industry leaders Brocade, Computer Associates, Intel, McDATA, Microsoft and VERITAS among our strategic partners. We market to OEMs and end users through our own worldwide selling organization as well as our two tier distribution partners, including ACAL, Avnet, Bell Microproducts, Info-X, Netmarks, Tech Data, Tidalwire and Tokyo Electron. Corporate headquarters are located in Costa Mesa, California. As of September 28, 2003, we had a total of 403 employees. References contained herein to “Emulex,” the “Company,” the “Registrant,” “we,” “our,” and “us,” refer to Emulex Corporation and its subsidiaries.

Subsequent Events

On October 8, 2003, Emulex and Vixel Corporation, a Delaware corporation, or Vixel, announced that the two companies have signed a definitive agreement for us to acquire Vixel, a leading supplier of embedded switch ASICs and subsystems for the storage networking market. Under the terms of the agreement, we will acquire Vixel for $10 per share in cash, for an estimated transaction value of approximately $310.0 million. The acquisition is structured as a cash tender offer for all of the shares of Vixel. Any Vixel shares not acquired by us in the tender offer will be acquired in a second step merger in which remaining Vixel shareholders will receive the same cash price per share as that paid in the tender offer. In addition, we will assume all existing vested and unvested Vixel stock options. The tender offer is expected to be completed in November 2003, subject to regulatory approvals and certain closing conditions, including the tender of a majority of shares of capital stock of Vixel on a fully-diluted basis.

On October 17, 2003, we acquired the technology assets of Trebia Networks, Inc. and Trebia Networks Securities, Inc., or Trebia. The acquired technology includes multiprotocol storage networking processor architectures and high-performance offload engines. The purchase price was $2.0 million in cash, with $0.5 million of that amount placed in an escrow account for at least 90 days.

The purchase price allocations have not been finalized for the pending Vixel acquisition and the completed Trebia technology asset acquisition. However, significant amounts may be allocated to in-process research and development, or IPR&D, and to intangible assets, resulting in IPR&D expense and/or intangible asset amortization expense that would have a significant impact on our results of operations.

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Results of Operations

The following discussion and analysis should be read in conjunction with the Condensed Consolidated Financial Statements included elsewhere herein.

Net Revenues

Net revenues for the first three months of fiscal 2004 ended September 28, 2003, increased $14.2 million, or 20 percent, to $84.6 million, compared to the same three months of fiscal 2003 ended September 29, 2002.

From a product line perspective, net revenues generated from our Fibre Channel products for the three months ended September 28, 2003, were $84.1 million, an increase of $15.3 million, or 22 percent, compared to the three months ended September 29, 2002, and represented 99 percent of total net revenues. We continue to believe that our net revenues from our Fibre Channel products are being generated primarily as a result of our product certifications and qualifications with OEM customers, which take product both directly and through distribution channels.

Net Revenues by Product Line

Our IP networking products consist of both our iSCSI products, which are currently in development, and VI products; as well as legacy cLAN products. We expect that our VI, cLAN and traditional networking products, which have all entered end-of-life status, will contribute negligible revenues to succeeding quarters. Although we continue to devote resources to iSCSI product development, the market remains in an early stage of development and we do not expect material revenue from these products for the foreseeable future.

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In addition to direct sales, some of our larger OEM customers purchased or marketed products indirectly through distributors, resellers or other third parties. Customers whose direct net revenues or total direct and indirect net revenues (including customer-specific models purchased or marketed indirectly through distributors, resellers and other third parties) exceeded 10 percent of our net revenues, were as follows:

Net Revenues by Major Customers

	(1)		Amounts less than 10 percent are not presented
	(2)		Customer-specific models sold indirectly are included with the OEM’s revenues in these columns rather than as revenue for the distributors, resellers or other third parties.

Direct sales to our top five customers accounted for 74 percent of total net revenues for the three months ended September 28, 2003, compared to 67 percent in September 29, 2002, and we expect to be similarly concentrated in the future. Our net revenues from our customers can be significantly impacted by changes in the business models of our customers. Beginning in late 2002, EMC began sourcing more product through distribution rather than purchasing it directly. Consequently, direct sales to EMC have been impacted, while indirect EMC revenues through distribution have risen.

From a sales channel perspective, net revenues generated from OEM customers were 57 percent of net revenues and sales through distribution were 43 percent in the three months ended September 28, 2003. Our OEM customers may take products both directly and through distribution channels.

Net Revenues by Sales Channel